ASSIGNMENT
OF ANNUITY CONTRACT FOR CONSOLIDATION IS TAX-FREE EXCHANGE.

The
Service has ruled (Rev. Rul. 2002-75) that an individual's assignment of an
annuity contract for consolidation with a pre- existing annuity contract is a
tax-free exchange under section 1035.

The individual owns two
annuity contracts issued by two different companies. The individual, who is the
obligee for both contracts, wants to consolidate them. She will assign the
contract issued by the first company to the second company. The first company
will transfer the entire cash surrender value of the contract directly to the
second company, which will include that amount in the second contract.

The individual will not receive
any of the cash surrender value of the transferred contract, and she will pay
no consideration in the transaction. The terms of the second contract will be
unchanged by the transaction, and the first contract will terminate.

In ruling that the assignment
will be a tax-free exchange, the Service noted that the legislative history of
section 1035 states that tax-free exchange treatment is appropriate for
individuals who exchange one insurance policy for another better suited to
their needs and who have not realized gain. The IRS further ruled that the
individual's basis in the second contract immediately after the exchange will
equal the sum of her basis in the two contracts immediately before the
exchange. The Service also concluded that after the assignment, the
individual's investment in the second contract under section 72 will equal the
sum of her investments in the two contracts immediately before the exchange.

Full Text

Rev. Rul. 2002-75

ISSUES

[1] Is the taxpayer's assignment of an entire annuity contract to a second
insurance company, which then deposits the cash surrender value of the assigned
annuity contract into a pre-existing annuity contract owned by the same
taxpayer, and issued by the second insurance company, a tax-free exchange under
§ 1035? What is the basis under § 1035 and the investment in the surviving
contract under § 72 after the transfer?

FACTS

[2] A owns Contract B, an annuity contract issued by Company B, and Contract
C, an annuity contract issued by Company C. A is the obligee for both
contracts. A seeks to consolidate Contract B and Contract C. A assigns Contract
B to Company C. Company B transfers the entire cash surrender value of Contract
B directly to Company C. Company C includes the transferred cash surrender value
of Contract B in Contract C. A will not receive any of the cash surrender value
of Contract B that is transferred to Company C and deposited into Contract C.
No other consideration will be paid by A in this transaction. The terms of
Contract C are unchanged by this transaction, and Contract B terminates.

LAW AND ANALYSIS

[3] Section 1035(a)(3) provides that no gain or loss shall be recognized on
the exchange of an annuity contract for an annuity contract. Section 1.1035-1
of the Income Tax Regulations provides that the exchange, without recognition
of gain or loss, of an annuity contract for another annuity contract under §
1035(a)(3) is limited to cases where the same person or persons are the obligee
or obligees under the contract received in the exchange as under the original
contract.

[4] The legislative history of § 1035 states that exchange treatment is
appropriate for "individuals who have merely exchanged one insurance
policy for another better suited to their needs and who have not actually realized
gain." H.R. Rep. No. 1337, 83d Cong., 2d Sess. 81 (1954).

[5] Section 1035(d)(2) cross-references § 1031 for the rules to determine
the basis of property acquired in a § 1035 exchange. Section 1031(d) provides
that property acquired in a § 1035 exchange has the same basis as that of the
property exchanged, decreased by the amount of any money received by the
taxpayer and increased by any gain (or decreased by any loss) recognized by the
taxpayer on the exchange.

[6] Section 1.1031(d)-1 provides, in part, that in a § 1035 exchange the
basis of the property acquired is the same as the basis of the property
transferred by the taxpayer with proper adjustments to the date of the
exchange.

[7] Section 72 governs the federal tax treatment of distributions from an
annuity contract. For purposes of determining income, gain, or loss from an
annuity contract, § 72 contains two special definitions of investment in the
contract. When amounts received are not annuity payments, § 72(e)(6) defines
the investment in the contract. For purposes of § 72(b), which applies to
annuity payments, § 72(c)(1) defines the investment in the contract in a
similar, but not identical, manner.

[8] After completion of the transaction, A owns only Contract C, which has
been increased in value to reflect the cash surrender value transferred into it
from Contract B. A had no access to the cash surrender value transferred in the
exchange. Therefore, this transaction is treated as an exchange that is
tax-free under § 1035.

[9] As a result of the application of § 1035(d), A's basis in Contract B is
included in A's basis in Contract C immediately after the exchange, and under §
72(c)(1) and § 72(e)(6), A's investment in Contract B is included in A's
investment in Contract C immediately after the exchange.

HOLDINGS

[10] (1) The assignment by A of Contract B to Company C for consolidation
with pre-existing Contract C is a tax-free exchange under § 1035.

[11] (2) After the assignment, pursuant to § 1035, A's basis in Contract C
immediately after the exchange equals the sum of A's basis in Contract B and
A's basis in Contract C immediately prior to the exchange.

[12] (3) After the assignment, A's investment in Contract C under § 72
equals the sum of A's investment in Contract B and A's investment in Contract C
immediately prior to the exchange.

DRAFTING INFORMATION

[13] The principal author of this revenue ruling is Ann H. Logan of the
Office of Associate Chief Counsel (Financial Institutions and Products). For
further information regarding this revenue ruling, contact her at (202)
622-3970 (not a toll-free call).